Private Benefits of Control An International Comparison Dyck, Alexander and Luigi Zingales, 2004

Question 1

PBOC: background

Answer 1

• Benefits that are not shared among all shareholders in proportion of the shares owned, but are
  exclusively enjoyed by parties in control: psychic value, outright theft, transfer pricing, using
  insider info for personal gain. PBOC involves costs: maintaining a control block means lack of
  diversification + distressed companies might inflict reputational losses or even legal liabilities to
  the controllers. PBOC is not always bad: managers exploiting profitable investments without
  company’s assent might actually create value. PBOC makes value enhancing and socially
  beneficial takeovers possible.
• Two main ways of measuring PBOC: Difficult to measure directly. If PBOC were easily
  observable and quantifiable, they would not be private and would be claimed by minority
  shareholders in court.

Question 2

HOW TO CAPTURE IT

Answer 2

• 1. Control premium: the difference between the price per share of the control block and the
     market price per share. Drawbacks: Sales of control blocks are rather rare; delay in incorporating
     public information to the market price. 2. Price difference between shares in a dual-class
     system. Extra voting rights as a proxy for corporate control. Drawback: dual class shares are not
     allowed in every country.
• Issue: Both measures capture only common value component. If there is a benefit of owning a
  company that is unique for an incumbent, it is by definition impossible to find a buyer that will
  agree on the value of PBOC in this case.

Question 3

Things that affect the size of PBOC premium
(theoretically):

Answer 3

The authors find some evidence for the size of block traded (pay more for 51% of shares than 30%
because when you have 51% you are in total control). Authors do not find significance of presence
of another large shareholder (if there is another large shareholder, you have to share your PBOC,
you are not happy, you pay less).
The authors find some evidence for sellers bargaining power - reflects whether seller is in a position
to demand more money from the buyers. If the company is in a financial distress, a large seller is
willing to sell shares for less. PBOC are then undervalued/can be negative because of lack of
investor’s diversification.
The authors find some evidence in the case if the institutional buyer is a foreigner. Foreigners pay
more (less information and connections = more bargaining power for the seller). Authors do not find
significance of industry. PBOC also differ across industries. Controlling a media company gives you
enormous power of manipulating public opinion in personally beneficial ways.
Authors do not find significance of tangibility of assets. If company’s assets are mostly tangible,
they are harder to expropriate due to their visibility, thus lowering PBOC. Finance industry as a
contrast.

Question 4

How does PBOC affect financial development?

Answer 4

In countries showing high PBOC, entrepreneurs are reluctant to make their companies public
because investors do not factor in the control value (less IPOs). Potential buyers of smaller stakes
also attribute less value to shares taking into account being exploited by majority shareholders. As
a result, selling control in private negotiation is more profitable than in the market with
dispersed buyers buying many noncontrolling stakes (privately negotiated deals).
Three implications apply to countries with high PBOC:
1. Fewer companies are public; the equity markets are underdeveloped which hinders firm
financing.
2. Afraid of ending up in the minority position, incumbents seek to retain control after going public,
thus there should be less widely held companies.
3. To maximize profit, governments should sell companies privately rather than in public offerings.

Question 5

REMARKS: What helps curbing and eliminating
PBOC?

Answer 5

• Legal institutions: 1. The legal environment. Greater ability to sue controlling shareholders and greater shareholder
  protection = this works. 2. Disclosure standards. The more extensive and accurate disclosed information is, the more it
  curbs appropriation by increasing the risk of legal consequences or reputational costs (SEC in the US) = this works. 3.
  Enforcement. Quicker, smoother and more predictable enforcement, the stronger the legal protections of shareholders =
  this works. Legal institutions are strongly associated with lower levels of private benefits.
• Courts cannot easily restrict managerial discretion. BUT! Extra-Legal institutions may play an important role in
  constraining private benefits, both in settings with legal protections as well as in settings where legal protections are
  nonexistent or not enforced.
• 1. Product market competition. Through prices, competitive markets can verify manipulated transfer prices. = this
     works. 2. Public opinion pressure. Value appropriation can be limited by expected reputational losses = this works. 3.
     Moral norms. Value appropriation cannot be undertaken due to moral considerations. Religious traditions? Crime rate? =
     this doesn’t work. 4. Labor as monitor. The risk of employees quitting due to dishonest activities by majority
     shareholders. What if employees benefit from PBOC? = this doesn’t work. 5. Government as a monitor through tax
     enforcement. Through taxes the state acts as an investor to all companies. It does not have agency/free-rider problems, and
     has power unavailable to regular shareholders: better tax enforcement can reduce PBOC= this works.